Sometimes borrowing from your life insurance policy can make financial sense, as might be the case with a sudden financial emergency or debt that needs to be paid. Depending on what type of life insurance policy you have, the loan can even be tax-free, unlike simply withdrawing money from the policy. The loan isn’t interest-free, though, and the interest is not deductible.
Here’s how it works.
Borrowing Tax Free
If you or your spouse has a whole life insurance policy, you’re eligible to take a loan out. Term life policies are not eligible.
So, does this mean I can get whole life insurance this month and take a loan next month? No. What you’re actually borrowing are the premiums you and your spouse have paid in. If you’ve paid $15,000 in premiums, you can take one or several loans totaling $15,000, tax-free. The amount of your policy – whatever it may be – is the collateral for the loan.
Do I have to pay back the loan? Yes, and interest on the loan accrues annually. The interest must be paid annually, and if not, it’s added to the loan amount. Failing to repay your loan and interest means that the loan may become taxable income. Also, if you or your spouse die with an outstanding loan or interest balance, the balance is deducted from your policy’s amount. This means that there will be less money for your beneficiary.